Savings Taxation Directive review – briefing

The European Commission adopted on 13 November an amending proposal to the Savings Taxation Directive, with a view to closing existing loopholes and eliminating tax evasion. Since 2005, the Savings Directive ensures that paying agents either report interest income received by taxpayers resident in other EU Member States or levy a withholding tax on the interest income received. The Commission proposal seeks to better ensure the taxation of interest payments which are channelled through intermediate tax-exempted structures. It also proposes to extend the scope of the Directive to income equivalent to interest obtained through investments in some innovative financial products as well as in certain life insurances products. Moreover, simplification of the technical operation of the Directive should lead to a more user friendly system and more efficient implementation.

• According to Article 18 of the Savings Directive, the Commission must report to the Council on the operation of the Directive every three years and propose any amendments to the Directive that may be required in order to better ensure effective taxation of savings income.
• Recent tax evasion cases have clearly demonstrated the importance of international cooperation in the area of direct taxation, with a view to preventing fraud and evasion linked to cross-border financial investments.
• Tax fraud and tax evasion deprive EU Member States of the essential financial resources. Today this problem is more acute than ever as governments will be facing the first effects of the financial crisis. While well-off individuals tend to benefit most from the existing loopholes in the Savings Tax Directive, the first victims of tax fraud and tax evasion are the least mobile workers and consumers who can face high taxation levels that the Member States introduce to compensate for their losses.

First, the Commission proposes to improve the Directive so as to better ensure taxation of interest payments which are channelled through intermediate tax-exempted structures.

• For interest payments made by paying agents established in the EU to certain intermediate structures established outside the EU, the Commission proposes that those paying agents subject to anti-money laundering obligations are required to use the information already available to them within this framework to establish the actual beneficial owner of these payments. When the latter is an individual resident in another EU Member State, the paying agent would consider the payment concerned as directly made to this individual.
• For interest payments made to certain untaxed intermediate structures established within the EU, including some non-charitable trusts and foundations, those structures will be always obliged to apply the provisions of the Directive (exchange of information or withholding tax) upon receipt of any interest payment from any upstream economic operator wherever established.

Second, the Commission proposes to extend the scope of the Directive to income obtained from investments in some innovative financial products with capital protection (less than 5% risk coverage) and in certain life insurance products.

Third, the proposal brings a major reduction of administrative burden for individuals who opt for exchange of information in Austria, Belgium or Luxembourg where they receive interest payments and therefore claim exemption from withholding tax. The proposal asks that the paying agent will directly report information to the tax authorities, at the request of the individual who authorize it, in place of levying the withholding tax.

Fourth, the Commission proposes to ensure a level playing field between all investment funds or schemes, independently of their legal form.

Fifth, it proposes technical improvements which are beneficial for the activity of paying agents, such as a clearer treatment of investment funds established in a country different from the one of the paying agent and a clearer guidance for Member States in order to avoid possible cases of duplication of paying agent responsibilities.

The table below displays available information, for the countries levying a withholding tax, about the amount of revenue shared with the other Member States.

The sum of the tax revenue shared in 2006 by countries applying the withholding tax regime is 500 million €. It corresponds to 75% of the withholding tax collected by those countries applying the withholding tax system. Given that 25% of the amount collected is kept by the country having levied the withholding tax, the total tax withheld is about 670 million €. If one assumes that the withholding tax was 15%, this would represent total interest payments of about 4.5 billion €.

It has first to be noted that the data provided by Member States and other jurisdictions covered by the savings taxation measures contain a critical number of missing values. This leads to the problem that the data must be interpreted with caution, since missing values significantly reduce the number of observations for certain jurisdictions.

The data on information exchange from EU Member States and other jurisdictions show that reported interest payments increased significantly between the second half of 2005 and 2006. Unsurprisingly, the largest payments can be found in the largest economies.

The total amount of interest payments made, for which information was exchanged, is shown in the following table. It has to be stressed that it does not correspond to any amount of tax collected. The Member States, having been informed that interest payments were made to individuals resident on their territory, have then applied, if appropriate, a tax according to their own tax regime. Given that the tax regimes within the MS differ from each other, it is impossible to give an estimation of the amount of money collected corresponding to the interest payments reported

Taking the very conservative assumption that the UK would report a similar amount for the fiscal year 2006 to what it reported for the period between July 2005 and April 2006, it can be extrapolated that the total of interest payments made for which information was exchanged is 20bn € in 2006.

The economic analysis made by the Commission has shown that:

• the introduction of the Directive does not appear to have led to major changes in the composition of savings incomes;
• there has been an observable shift from countries within the scope of the Directive towards third countries for deposits of depositors which are either individuals or companies excluding banks. This development took place before the Directive came into force. It has to be taken into account that currently available statistics on international deposits do not allow to make a split between the two types of depositor (individual depositors – subject to the Directive and corporate depositors – not subject to the Directive).

Not necessarily.

Under the money laundering Directive the paying agents should already have the information requested.

Moreover, the introduction of the new annex (indicative compliance list) will bring more clarity and legal certainty to paying agents. Furthermore, the proposal contains technical improvements which are also beneficial for the activity of paying agents, such as a clearer treatment of investment funds established in a country different from the one of the paying agent and a clearer guidance for Member States in order to avoid possible cases of duplication of paying agent responsibilities. .

Given that the scope of the Directive is extended to ensure a level playing field between equivalent products and intermediaries, it is clear that the proposal will introduce new burden on some paying agents that are not yet in the scope of the Directive (some trustees and some insurance companies).

Some voices have called for a more radical extension of the scope of the Directive to any kind of investment income. The Savings Taxation Directive may, however, not be the most suitable framework for improving cooperation between tax authorities for those items of income whose tax treatment varies considerably between Member States (like dividends or capital gains from those speculative financial instruments which do not provide substantial capital protection).

Solutions based exclusively on the exchange of information would also seem more appropriate for the purpose of ensuring that neither double taxation, nor avoidance of any taxation, arise in relation to those life insurance contracts where a significant share of the premiums paid serve to cover risks, or with regards to pensions.

The Commission is currently working on a review of the Directive on Mutual Assistance between the tax authorities of Member States (Directive 77/799/EEC) that could improve the conditions for cooperation on these forms of income. Proposals should be expected before the end of this year.

Once Member States agree on the ways of closing existing loopholes, the Council is expected to ask the Commission to examine with non-EU countries and jurisdictions participating in the mechanism as to how to update the respective agreements in a similar way. However, it is premature to speculate today on how they will react to our approach, as the EU first needs to reach a unanimous agreement internally.

Following the request of the ECOFIN Council, the European Commission launched discussions with selected important financial centres, namely Hong Kong, Singapore and Macao in order to extend the geographical scope of the existing Directive. The discussions are on-going at present and it is too soon to anticipate their outcome.

Formal negotiations will start shortly with Norway, at its request, whilst other jurisdictions like Bermuda and Iceland have shown interest in participating in the savings taxation arrangements.

NO! Annex 1 of the proposal does not have anything to do with the so-called “black-list” of tax heavens. Annex 1 is based on an analysis of the tax regime of the specific entity or legal arrangement in the corresponding named jurisdiction mentioned. Only those entities and legal arrangements to which EU resident individuals can have access as beneficial owners and which are not subject to effective taxation on their income in that jurisdiction are mentioned in the list. Its purpose is to facilitate the job of the paying agents in executing the application of the Directive. Appropriate procedures are provided to amend the list if the information contained in it needs to be updated.

The Commission proposes to extend the scope of the Directive to cover substantially equivalent income derived from those products that, from the investor’s viewpoint, can be regarded as equivalent to debt claims because their risk is known and is not higher than that of debt claims.

Therefore, the proposal extends the scope of the Directive to the following products:

• securities where the investor receives: a) a return on capital whose conditions are defined at the issuing date; and b) a guarantee where, at the end of the term of the securities, at least 95% of the capital invested will be reimbursed. All securities meeting these two conditions will be included in the scope, regardless of whether the underlying assets behind those securities include debt claims or not. Typical examples are structured products like those “index linked certificates” whose performance is defined ex ante as being a function of the possible positive trend of a market indicator or to the increase in value of a basket of underlying securities, whilst the possible negative results of the market indicator or of the underlying securities has no or minimal influence on the right for the holder to be reimbursed the capital invested;
• those life insurance contracts whose positive performance (beyond the guarantee of reimbursement of the capital invested) is strictly linked to income from debt claims or equivalent income and where the mortality or longevity risk covered under the contract is merely ancillary (lower than 5% of capital insured as an average over the duration of the contract).

The possibility to include a positive list with the products that meet these criteria was eventually discarded for practical reasons, associated with the rapid developments in the financial markets that would very quickly make the list obsolete: any updating of the list would come too late. The Commission considers that the above described criteria for identifying the products concerned provide enough clarity to paying agents and that a detailed list is not necessary.

• If the trust or foundation (or other equivalent entity on arrangement) is established outside the EU in a jurisdiction listed in annex I of the Directive (because it is untaxed), the Commission proposes that the paying agents established in the Union and subject to anti-money laundering obligations would be required to use the information already available to them within this framework to determine the effective beneficial owner of these payments. When the latter is an individual resident in another EU Member State, the paying agent would consider the payment concerned as directly made to this individual, without taking into account the formal transit of the payment through the intermediate structure. For instance, if a bank established within the EU pays interest to a trust established in Switzerland or in Hong-Kong and if it knows, under the anti-money-laundering provisions, that the effective beneficial owner of the trust is an individual resident in the EU, the bank will be required to apply the provisions of the Directive at the time of the payment to the trust as if this payment was directly made to this individual.
• If the trust or foundation (or other equivalent entity or arrangement) on its income under the general rules for direct taxation applicable in the Member State, the provisions of the Directive (exchange of information or withholding tax) should apply upon receipt of the payment by this entity. To facilitate the task of economic operators, the Commission has established a first list of such entities or arrangements established in the EU. This list is to be found in annex III of the directive and will be completed and updated with the assistance of Member States in the framework of a Committee. For instance, if a trust established within the EU receives interests from an economic operator (bank, financial institution, independent professional) wherever established, it will be obliged to apply the provisions of the Directive (exchange of information or withholding tax) upon receipt of the payment, regardless of the actual distribution of any sum to the individual beneficial owner.

Currently, income obtained by individuals through some investment funds (mainly investment funds subject to the UCITS Directive) is already within the scope of the Directive. The Commission proposes to extend the scope of the Directive to all investment funds or schemes, wherever located and independent of their legal form and regulatory regime, having invested in debt claims or other equivalent securities.For this purpose, all the current references to the UCITS Directive for investment funds established in the EU will be replaced by a reference to the registration of the fund in accordance with the domestic rules of any of the Member States; for investment funds established outside the EU, a broad definition of investment funds or schemes based on concepts prevailing at OECD level will be used.